OECD cautions NZ to limit fiscal stimulus

Additional fiscal stimulus beyond that already planned could put the economy's projected "soft landing" at risk, the latest OECD report on New Zealand says.

The Paris-based agency said such a scenario would need to be offset by higher interest rates to bring the economy back on to a sustainable growth path. It said economic growth had been running ahead of potential, with labour shortages and inflationary pressures mounting.

"Higher interest rates will damp domestic demand through the coming year, although this will be offset by the income effects of the 'working for families' package.

"Increased business investment will help ease capacity constraints and pave the way for higher productivity growth and increasing real wages." It said demand continued to be fuelled by a vigorous expansion in Government consumption.

The OECD said the seven interest rate hikes since the start of last year should be enough to return the economy to a more sustainable path and give the Reserve Bank room to start easing rates slowly during next year.

"However, its task has been complicated by the fiscal stimulus that has come from additional Government spending in 2004 and 2005. Any further relaxation of fiscal policy would need to be offset by higher interest rates."

The OECD said that with the economy close to a turning point in the cycle, monetary judgments were especially difficult. If policy turned out to be too tight, the pace of activity could slow more rapidly and painfully - but if inflationary pressure remained instead, the authorities might need to squeeze markets harder, raising the likelihood of a downturn.

The OECD expects gross domestic product growth to slow to 2.9 per cent this year and 2.4 per cent next year, from 4.8 per cent in 2004.

That compares with Treasury forecasts of growth slowing from 4.2 per cent in the year to March this year to 2.3 per cent next year and 2.5 per cent in 2007.

The OECD is forecasting annual inflation to hit 3.2 per cent next year - above the Reserve Bank's 1-3 per cent target band.

- NZPA